Part 2, Module 5: Mortgage Default and Foreclosure
Mortgage Default and Foreclosure
Under a typical mortgage arrangement, the borrower has the right to live on the property used as security for the loan. However, the lender retains certain powers over the land. These rights typically include the ability to impose a lien or take possession of the property used to secure the mortgage loan in the event of default.
This final module reviews the events that give rise to default, the rights and remedies available to lenders when borrowers default, and the defenses available to borrowers in foreclosure.
Default occurs when a mortgage borrower fails to meet the terms of mortgage contract. Default is usually triggered by a failure to make monthly payments. Different lenders define default differently, however, so whether a borrower is in default depends upon the terms of the mortgage. For example, some contracts only place a mortgage borrower into default for repeated failure to make payments. Some agreements allow borrowers to miss up to three payments before they are in default. Other agreements trigger default if the borrower fails to make a single payment.
When a borrower is in default, the lender may pursue a variety of remedial options available under the terms of the mortgage. Most mortgages include an “events of default” section, which specifies the events and conditions of default. Just like any other contract, mortgage borrowers and lenders are responsible for understanding and abiding by these terms.
Once a borrower triggers a default, a lender must provide the borrower with appropriate notice. The notice must set forth the nature and extent of the default, the date by which default must be remedied, and the rights that the lender can exercise if the borrower fails to remedy the default.
In addition to contractual notice provisions, some borrowers may be entitled to statutory notice depending on the rules of the jurisdiction. Once notice has been properly served, a lender may exercise any remedies allowed under terms of the mortgage agreement. In addition to exercising contractual remedies available under the terms of the mortgage, a lender may seek a court-ordered resolution, or proceed pursuant to Article 9 of the Uniform Commercial Code (UCC) if the mortgage was secured by personal property.
Negotiated Remedies to Mortgage Default
Once a lender determines that a borrower is in default, the lender may choose to exercise a mortgage liquidation option included in the agreement or remedy the issue by working directly with the borrower. Like most legal processes, responding to a mortgage default event through the court system can cost lenders time and money. As a result, lenders may choose to pursue negotiated resolutions rather than relying on court enforcement of legal remedies.
For example, a lender may elect to give the borrower a waiver, which means the lender agrees to waive the event that gave rise to default. Waivers are not particularly common. Lenders may also elect to execute a forbearance agreement, under which the lender agrees to not declare default with respect to a certain event for a specified time in exchange for a payment (or promise of payment) by the borrower. This consideration is negotiated privately, so the terms of a forbearance agreement can vary substantially from case to case. These agreements nearly always require the borrowers to guarantee that no further defaults will occur. Alternatively, a lender may agree to amend or pursue an out-of-court restructuring of the mortgage. In either case, the lender and borrower can renegotiate certain terms of the mortgage agreement in hopes of avoiding future default and foreclosure.
If negotiated resolutions are not possible, a lender may be left with no other option than initiating a liquidation of the property. Mortgage liquidation options include foreclosures and short sales. A foreclosure is the process by which a lender repossesses real property after a borrower defaults on the mortgage. Laws governing foreclosure procedure vary widely depending on the jurisdiction. 
A short sale is another way to avoid foreclosure when the house is not worth as much as the mortgage. The borrower agrees to allow the bank (usually through a real estate agent) to sell the property for as much as it can get and then walk away. In exchange, the bank does not hold the borrower liable for the difference between the balance owed on the mortgage and the sale price.
The process of foreclosure is allowed in all U.S. jurisdictions and even required in some states following certain events of default.  Foreclosures are often initiated in the initial stages of the default. The foreclosure process takes a long time and negotiations may take place during this time. Banks often start on foreclosure actions to demonstrate that the borrower is in danger of losing her home and pressuring her to negotiate a settlement in good faith. Foreclosure actions can always be dismissed or not pursued when the settlement comes.
The result of the successful foreclosure action is the bank seizing control the property, usually to sell it to recoup its debt, a process known as a foreclosure sale. States regulate advertisement of foreclosure sales and the sales themselves. Most jurisdictions require mortgage lenders to conduct a “fair” foreclosure sale.  Some states require that foreclosures be done through judicial proceedings (a “judicial” foreclosure), while many allow the process to be handled outside of court (a “non-judicial” foreclosure).
Judicial foreclosure sales require the lender to file suit against the borrower. The borrower receives notice from the judiciary demanding payment rather than from the lender itself. The borrower has 30 days to respond and remedy the default. If the borrower fails to remedy the default within the 30-day period, a public auction is held, and the property is sold to the highest bidder.
Another form of foreclosure, referred to as a “power of sale” foreclosure, can only be carried out if there is a power of sale clause in the mortgage agreement. Once notice has been properly served and the waiting period provided in the agreement has elapsed, the lender initiates an auction. The lender is responsible for carrying out the legal process to effectuate the sale. These auctions are often quicker and easier for lenders than judiciary auctions. However, some jurisdictions impose additional requirements on lenders to ensure the legality and fairness of the auction.
In a few jurisdictions, the law allows lenders to pursue strict foreclosure. The lender initiates the proceeding in court after a default. If the court determines that the borrower cannot pay the mortgage as promised, then the real property is conveyed to the lender. Notably, this type of foreclosure is only used when the debt amount is greater than the value of the property. Under these circumstances, conveying the property to the lender can be the only way that the borrower can be released from an overly-burdensome mortgage.
If a foreclosure sale nets less money than the bank is owed (and keep in mind that the bank will add its costs in the foreclosure action, real estate broker fees and all its expenses in effecting the foreclosure to the mortgage debt), whether the bank can then proceed against the borrower for the difference depends on whether the loan is a recourse loan or a nonrecourse loan. In a recourse loan, the bank has “recourse” to collect and even sue the borrower for the difference. Some states prohibit recourse loans, and thus all mortgage loans in those states are nonrecourse. Since banks write the terms of the mortgages and greatly prefer recourse loans, one can assume that most loans made in states that allow recourse loans are recourse loans.
Defenses to Mortgage Foreclosure
There are defenses that apply to both judicial and nonjudicial foreclosure proceedings. For example, a lender’s failure to comply with notice requirements, whether contractual or statutory, can be raised as a defense.
Federal consumer protection laws provide mortgage borrowers with some affirmative claims that may be used in response to a foreclosure action. These claims must be raised as a defense to a complaint for judicial foreclosure or brought as a separate lawsuit, whereby the borrower can seek an injunction to stop foreclosure proceedings.  These laws include the Truth in Lending Act, the Home Ownership and Equity Protection Act, and the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Truth in Lending Act requires lenders to provide borrowers with full disclosure of the terms and conditions of the loans they make. The lender’s failure to comply with the terms of the Act can be used as defense against a foreclosure action. However, mortgage rescissions under the Act must be brought within three years of the origination of the mortgage. After three years, the protections of TILA expire.
A borrower may also be able to raise a claim under the Home Ownership and Equity Protection Act, which regulates high interest and predatory loans.  That Act requires certain disclosures in cases of high-cost mortgages, including those with interest rates more than 8 points higher than the going interest on treasury bills. Violations of the Act may result in successful foreclosure defense and can also lead to an award of damages and possibly rescission.
Both Acts provide ways that borrowers can legally rescind mortgage agreements, which nullifies the contract and moots any alleged default. Otherwise, borrowers can suspend or avoid the foreclosure process under Dodd-Frank, which, in part, was designed to ensure that borrowers have assistance if they are having trouble paying their mortgages and protect borrowers from wrongful actions taken by mortgage servicers.
Under Dodd-Frank, mortgage servicers must assist borrowers who are having trouble paying their mortgages. If a borrower falls behind on mortgage payments, servicers must attempt to contact the borrowers to discuss their options no more than 45 days after the missed payment. If appropriate based on the circumstances, the servicer must inform the borrower of loss mitigation options, including modification of the mortgage terms, short sale and other options. Further, the servicer must assign personnel to assist the borrower no more than 45 days after the borrower becomes delinquent. The assigned personnel must educate the borrower regarding their options and assist with the completion and submission of mitigating applications. Most importantly, if the borrower has completed the applications more than 37 days before the scheduled foreclosure sale, the servicer must put the foreclosure on hold until the application is evaluated. 
In addition to the federal protections afforded to mortgage borrowers, state usury laws can also give rise to important defenses to foreclosure. These laws govern the amount of interest that can be charged on a loan.
All states have also enacted statutes that provide borrowers with a right of redemption. A right of redemption is a time in which the borrower can pay off the debt owed, or “redeem” ownership of the property. Jurisdictions vary in the time frames required to redeem, and time frames may vary based on circumstances. The relevant circumstances may include whether the foreclosure is non-judicial or judicial, whether the property has been abandoned and whether the right to redemption has been voluntarily waived pursuant to the terms of the mortgage.  When a right to redemption is granted, the borrower must pay the cost of getting the property back, which is the lesser of the amount that the buyer at the foreclosure sale paid for the home and the total amount owed on the mortgage loan, plus interest and expenses.
The mortgage process is a daunting and convoluted process for any prospective home buyer. Even after all the paperwork is executed and recorded, mortgage borrowers must deal with the ongoing risks of default and foreclosure. For an unfortunate number of American homebuyers, this risk is all too real. In fact, about one out of every two hundred households will have homes foreclosed upon.  As a result, it’s critical that prospective home buyers and homeowners have a firm understanding of the terms of their mortgage agreements as well as the statutes and regulations that apply in their individual jurisdictions.
There are a variety of options - contractual, negotiated, and legal – established to protect homeowners from unnecessary loss in the default and the foreclosure process. Understanding your rights as a mortgage borrower in default is a critical necessity, as informed borrowers are more likely to find a remedy to default before a foreclosure.
 See An Overview Of The Home Foreclosure Process, Federal Home Finance Agency, Office of Inspector General, at https://www.fhfaoig.gov/Content/Files/SAR%20Home%20Foreclosure%20Process_0.pdf.
 Larry R. Rothenberg,Reiterating The Importance of Serving a Notice of Default Prior to Acceleration of Mortgage Loans in Ohio, Weltman, Weinberg, & Reis Co., L.P.A (June 2010), available at http://www.weltman.com/?t=40&an=40259&format=xml&p=7734.
 Ohio, for example, requires lenders to serve notice before the acceleration of the foreclosure process may begin. Id.
 Negotiating the Loan Workout, Robinson Bradshaw Publication (January 2009), available at https://www.robinsonbradshaw.com/newsroom-publications-Negotiating-the-Loan-Workout-01-21-2009.html. See also https://www.lawinsider.com/clause/waiver-of-event-of-default.
 When Paying the Mortgage is a Struggle, Federal Trade Commission - Consumer Information, available at https://www.consumer.ftc.gov/articles/0187-when-paying-mortgage-struggle.
 See Foreclosure v. Short Sale, Diffen, available at https://www.diffen.com/difference/Foreclosure_vs_Short_Sale. See also Short Sale vs. Foreclosure, Legal Match, available at https://www.legalmatch.com/law-library/article/short-sale-vs-foreclosure.html.
 Foreclosure Laws and Procedures by State, RealtyTrac (2017), available at https://www.realtytrac.com/real-estate-guides/foreclosure-laws/.
 Wendell Finner, Foreclosure Negotiation and Defense, American Bar Association (2009), available at https://www.americanbar.org/newsletter/publications/solo_newsletter_home/finner.html.
 Chart: Judicial v. Nonjudicial Foreclosures, Nolo, available at https://www.nolo.com/legal-encyclopedia/chart-judicial-v-nonjudicial-foreclosures.html.
 Foreclosure Laws and Procedures by State, supra note 9.
 Christopher Winkler, The Power of the Power of Sale Clause, BiggerPockets (March 2016), available at https://www.biggerpockets.com/blogs/5708/48877-the-power-of-the-power-of-sale-clause.
 What is Strict Foreclosure?, LawInfo, available at https://resources.lawinfo.com/foreclosure/what-is-strict-foreclosure.html.
 See Wendell Finner, supra note 10. See also, Kendall Coffey, Foreclosure Defenses, (December 2008), available at https://www.miamidade.gov/business/library/reports/foreclosure-defenses.pdf.
 David A. Leen, Borrowers’ Defenses to Foreclosure, David Leen & Associates, PLLC (2003), available at https://cloudedtitles.com/documents/locations/WA/David%20A%20Leen%20on%20Defenses%20to%20Foreclosure_Washington%20State.pdf.
 See Sheedy v. Deutsche Bank Nat’l Trust Co. https://law.justia.com/cases/federal/appellate-courts/ca1/14-1246/14-1246-2015-09-01.html
 See Pub. L. No. 103-325, 108 Stat. 2190, codified to various parts of Truth in Lending Act, particularly 15 U.S.C. §§ 1601-02, §§ 1639-41.
 A mortgage servicer is the entity that collects monthly payments from borrowers on behalf of the holder of the loan. Pub. L.111-203, 124 Stat. 1376-2223.
 CFPB Rules Establish Strong Protections for Homeowners Facing Foreclosure, Consumer Financial Protection Bureau (January 2013), available at https://www.consumerfinance.gov/about-us/newsroom/consumer-financial-protection-bureau-rules-establish-strong-protections-for-homeowners-facing-foreclosure/.
 David S. Rich, For Purposes of New York Usury Laws, What Fees or Charges Are Included in Loan Interest Rates?, LexisNexis Legal Newsroom - Contracts and Commerical Law (October 2013), available at https://www.lexisnexis.com/legalnewsroom/commercial/b/contracts-commercial-law/archive/2013/10/17/for-purposes-of-new-york-usury-laws-what-fees-or-charges-are-included-in-loan-interest-rates.aspx.
 See Amy Loftsgordon, Key Aspects of State Foreclosure Law: 50 State Chart, Nolo (March 2015), available at https://www.nolo.com/legal-encyclopedia/50-state-chart-key-aspects-state-foreclosure-law.html.
 Loftsgordon, Right of Redemption Before (and After) Foreclosure, supra note 27.
 Homeowners Facing Foreclosure, Mortgage Bankers Association, see https://www.fdic.gov/about/comein/files/foreclosure_statistics.pdf.